Dollar index up ahead of last Fed meeting in 2023, markets expect central bank to hold 

The U.S. dollar index (DXY), a gauge of the greenback’s strength against six major counterparts, saw an increase on Wednesday ahead of the conclusion of a Federal Reserve (Fed) policy meeting, which could provide insights into the timeline for the U.S. central bank's interest rate reductions. 

Sterling showed weakness during the day, particularly after data revealed a contraction in the UK economy for October, heightening the risk of a recession. This situation could potentially complicate the Bank of England's (BoE) efforts to maintain its stance against rate cuts in its upcoming meeting on Thursday. 

As of 13:15 GMT, the DXY index recorded a 0.09% rise to 103.96, recovering most of the 0.31% drop from the previous day. 

Following the meeting, Fed officials are set to provide updated economic and interest rate projections.  

Although rates are widely expected to remain unchanged, investors will closely monitor Fed Chair Jerome Powell's stance on potential interest rate cuts in the first half of 2024. Additionally, attention will be on the central bank's "dot plot" for insights into policymakers' perspectives on the monetary policy outlook. 

While recent indications have suggested a soft landing, overnight data showed an unexpected increase in consumer prices for November. The futures market currently reflects traders' expectations of up to four quarter-point rate cuts next year, with the first potentially occurring as early as May. 

James Kniveton, senior corporate FX dealer at Convera, told the Reuters news agency that he agreed with the Fed being data=dependent, but the market "is already acting like rate cuts are baked in”. 

"If the Fed does push back tonight on those rate cut expectations, the dollar index may have an opportunity move back into the October range of 105-107," he said. 

Federal Reserve meeting: Markets.com’s Neil Wilson says Fed has reached terminal rate 

In his morning notes on Tuesday, Markets.com’s Chief Market Analyst Neil Wilson wrote that with the Fed highly likely to leave rates unchanged, all eyes would be on the central bank’s dot plot and economic projections, as traders look for monetary policy hints: 

“[The] FOMC is certain to hold the target range for the fed funds rate between 5.25% - 5.50%. This would be a third straight pause and all but nail on the sense that the terminal rate has been reached. More important for the market, will the new economic projections and so-called dot plot to gauge where policymakers think rates will in 2024? The market is currently pricing in aggressive cuts next year but so far Fed speakers have not gone along with this narrative – the December meeting provides the moment to shift the tone to lean into what the market is forecasting”. 

He added that the Fed cannot afford to sound too hawkish, given  

“Key is the median dot plot forecast – does the Fed stick to 50bps of cuts next year or lean towards the 100-150bps type range that the market has been expected? I would expect the former and the for the Fed to push back against the market here. Whether the market listens is another question. And this will depend on how hard the Fed pushes back – it can probably afford not to sound too hawkish since it’s clearly winning the battle against inflation – it just cannot declare victory yet. The problem for the Fed in declaring victory is that it needs to first see weakness in the economic data that just isn’t very visible yet”. 

Fed preview: Commerzbank says interest rate hikes off the table 

In their preview of the Federal Reserve meeting, which will likely have implications for the USD forecast, economists at Frankfurt-based Commerzbank wrote that interest rate hikes would likely be off the table, with Jerome Powell likely stressing inflation risks in his speech: 

“Further rate hikes are likely to be off the table, but the Fed is unlikely to be satisfied with the extent of rate cuts that the market has priced in. After all, falling yields could reignite inflationary risks. Therefore, Chairman Jerome Powell will continue to emphasize the risks to inflation. The question is whether he will succeed. 

Powell does not have an easy task. He has to convince the market that the Fed is hawkish, but not sound too hawkish to leave himself the option of cutting rates next year if the data is favorable. So Powell is in a tough spot. 

However, a dovish surprise is less likely given that expectations for rate cuts are already quite advanced. And Tuesday's inflation figures and Friday's employment data showed that we can still see dollar strength, if only for a short time. [We] would be cautiously optimistic for the dollar today”. 

At the time of writing, the DXY index was up 0.04% on the day, trading around the 103.90 area, as per MarketWatch data. The euro to dollar exchange rate was down 0.06% at $1.0789, while the pound to dollar rate saw the greenback gain 0.30% against sterling, with GBPUSD trading at $1.2527.